A pre-approval1 letter is a letter from a lender that estimates the amount you may be able to borrow for a home loan. It’s an important first step in the home buying process because it proves to the seller you’re a qualified and serious buyer.
Tip: Some lenders offer a pre-approval estimate option, which often has fewer requirements and takes less time than the typical pre-approval process. Ask your lender if this option is available for you.
In order to issue a pre-approval, the potential lender will evaluate your credit, potential debts, employment history and income. This is why at the beginning of the process, you’re asked to gather supporting documents like proof of income, proof of assets and personal information. If you’re granted a pre-approved mortgage loan, the lender will give you a pre-approval letter, which is typically valid for 60-90 days.
Example of pre-approval letter
(Note: The layout and wording will vary from lender to lender):
Congratulations! We are pleased to notify you that based on our evaluation of your credit, income, assets and other documentation you provided, you have been granted a PRE-APPROVAL. This letter provides you with the terms, which you have been qualified:
Anticipated purchase price
Total monthly mortgage payment
[This last part (the ‘final approval could be subject to’ section) will likely vary from lender to lender, so make sure you understand what your pre-approval is based upon.]
Contact us with any questions.
Now, let’s break it down.
- Anticipated purchase price: The maximum amount you may be able to borrow. Be sure to consider your own comfort level when it comes to what you can afford. A general guideline is to not spend more than 30 percent of your gross monthly income on all housing expenses, including:
- Homeowners insurance
- Private mortgage insurance (PMI, which you’ll only pay if you put less than 20 percent down)
- Homeowners association (HOA) fees
- Loan amount: The purchase price you and the seller agree upon minus the amount you plan to put down. For example, if the purchase price is $200,000 and you put 20% down (or $40,000), the loan amount would be $160,000.
- Loan program: The type of home loan you may qualify for, for example a 15- or 30-year fixed-rate mortgage.
- Loan term: The extent (or life) of the loan.
- Total monthly mortgage payment: This should take into account principal and interest, homeowners insurance, private mortgage insurance (PMI) and homeowner association (HOA) fees. And don’t forget to factor in the cost of utilities and maintenance in your monthly payments.
- Interest rate: The mortgage interest rate you may qualify for.
- TIP: The better your credit score, the better your interest rate and the less money you could spend over the life of the loan.
The last part of the pre-approval letter will likely vary from lender to lender, so make sure you understand what your pre-approval is based upon.
Pre-approval can help set you up for a smooth home buying experience, as well as give your offer a little extra leverage and you a bit more confidence.